Macroeconomic Factors and Financial Statements: Asset Writedowns During Recessions*
44 Pages Posted: 14 Sep 2007 Last revised: 9 Mar 2010
Date Written: February 2010
I examine the asset write-down decisions of firms during recessions. These decisions are jointly determined by a decline in asset value and by managers’ reporting incentives, both of which are affected in recessions. The two sources of asset value, value in use and value in exchange, decline simultaneously in recessions. Consequently, for a given decline in sales the probability of writing down assets in recessions increases by an additional one and a half times that of writing down in expansions. Managers with ‘bloated balance sheets’ that is, who have used their accounting discretion to report higher earnings in past are at least two times more likely to write down in recessions than in expansions. I do not find that asset write-downs by industry leaders in the previous quarter are more likely to lead to asset write-downs in recessions as compared to expansions. I also find that while the probability of write-downs decreases for highly levered, weak firms in recessions–firms that are less likely to get covenant violations waived – it increases for highly levered, strong firms. The key implication of my results is that it is essential to incorporate the broader context in which accounting choices are made when evaluating managers’ reporting decisions.
Keywords: Asset Impairments, Business Cycles, Value in use, Value in exchange
JEL Classification: M41, M43, E32, G12, G32, G33
Suggested Citation: Suggested Citation